FAIR Framework from Exit Right
This blog was originally posted on Mert Iseri’s personal medium page. Check it out here.
After countless interviews, we identified four common elements in what makes acquisitions work. These are the elements that founders and acquirers should focus on to maximize the value of any transaction.
We call this the FAIR framework. It’s what everybody wants, after all — a fair transaction. Founders want to be treated with respect and expect a return for their hard work. Acquirers want to avoid companies with skeletons in their closet or invest dollars in failed initiatives. In short, both sides want this to work out for the best: a scenario where one plus one equals one hundred.
FAIR stands for Fit, Alignment, Integration, and Rationale. Each element requires time and attention to develop. Here’s how each impacts the future of your company.
Fit: the connection from parallel company cultures.
Company culture is a powerful force. Culture is how people will act when no one is looking. It specifies the behavior that is tolerated and what gets promoted. A company is a collection of people and fit simply ensures that the two groups of people involved in the exit share a common set of values around their respective businesses.
A good demonstration of correct fit is the acquisition of Zappos by Amazon. Zappos was known for their customer-obsessed culture. Employees sent handwritten cards, spent hours chatting to a single caller, and even boarded flights to personally deliver packages containing misplaced valuables.1
Amazon shared their vision for a customer-first approach to business. They were so well-matched that Amazon’s Jeff Bezos mentioned he didn’t see it as an acquisition. Rather, he said: “I personally would prefer the headline ‘Zappos and Amazon sitting in a tree…’” — framing the transaction as the beginning of a romantic relationship. He was certainly correct in his assumption that it was the right choice for both cultures.
On the other hand, we’ve all seen how a bad fit can easily lead to disastrous deals. In 1989, Sony paid $4.8 billion in debt to purchase Columbia Pictures. Sony was a conservative Japanese technology giant, while Columbia Pictures was a fast-paced, US-based movie studio. Both companies had completely different operating cultures, and neither side had a plan for how to make them work together. After five years, Sony had written off $3.2 billion of its investment in Columbia Pictures. Not the future any of them wanted.
Cultural fit stems from developing long-term relationships. It is extremely important for founders to begin meeting folks in their target companies for this reason. There is a world of difference between an exciting first impression and a relationship of trust that develops over years. It is easy to feign fit in the short term, while it is difficult to maintain long-term.
Alignment: there is agreement among the key people involved in the decision.
It’s clear that both parties have multiple stakeholders that need to agree to the transaction. It’s important to note that alignment isn’t a point in time, but an element of the transaction that needs to be maintained. Clear communication, incremental steps to credibility, and most importantly, mutual trust make up the core components of alignment.
In the following chapters, we will see a master class in alignment in the way Pandora bought Next Big Sound from its CEO, Alex White. While it was Alex’s first startup, the board and the shareholders were in lockstep alignment. This was one of the key ingredients that led to a speedy decision and deal execution. We will also learn from serial operator Anne Bonaparte about how she struggled with a rogue board member who wanted to negotiate behind her back with the acquirer.
Founders should first ensure that there is alignment internally, meaning that the four key stakeholders from the startup’s perspective are aligned:
• Co-founders
• Board
• Investors
• Executive leadership
We recommend that all startups have an annual “Exit Talk” that acts as a standardized framework to ensure continuous alignment on exit expectations and timing.
Once the internal alignment is there, founders benefit immensely from determining alignment within the acquiring company in parallel.
Integration: there is a clear plan to integrate all elements of the business post- acquisition.
With every deal, the majority of the work that determines if the merger will be successful happens after the documents are signed. This means that there needs to be a plan for integrating everything: people, culture, technology, customer support, parking passes, you name it. Sometimes the task is mundane, like issuing employee IDs, and sometimes the plan is to do nothing.
A successful integration is intentional, with both parties paying attention to details at every step of the way. It is the founders’ responsibility to make sure there is a clear plan and purpose around integration, with key metrics to determine success.
Integrations are difficult, in part because there is so much to do tactically all without losing focus on the big picture. It’s a complicated process that will generate a lot of questions. The good news is that M&A teams appreciate founders who ask questions about what success looks like post-integration; it tells the acquirer that a founder is serious about creating shared value and getting the deal done. Don’t wait until the eleventh hour of negotiations to ask questions around integration. Once you start discussing a term sheet, it is completely standard to ask questions to clarify plans around integration.
A well-crafted integration plan is a critical element of a smooth transaction. Take the time to build it during the closing process, and revisit it post-transaction to ensure mutual accountability.
Rationale: the plan to create new value as a result of the combined capabilities.
This is the final element that determines the success and longevity of an acquisition. A strong rationale is the main ingredient for victory, and a weak one is often the culprit behind deals that end in defeat. The rationale is the core reason behind the acquisition that all parties will align with. And there needs to be a clear business rationale that convincingly predicts an oversized outcome that would not be possible if the two companies remained separate.
The starting point for the rationale is timing: Is now the right time to make this purchase? Is the buyer better off by partnering (becoming a customer or a distributor) or building their own competing product? Timing determines whether an acquisition happens or not. Further, the acquirer will need to have absolute trust in the fundamentals of the business in question.
Trust is created through a credible team, robust technology, and real customers — in other words, you need to create a mountain of evidence to breed confidence in the future plans. Think of this as a basic requirement. In order to even begin discussing a price, you have to be a trustworthy entity.
Assuming that the timing is right and your team is credible, then we can answer these critical questions: Why should this acquisition happen? What is the mathematical formula of the future value we will create together?
No matter how strategic, at some point in the future, the bill will come due. The acquiring company needs to financially justify their investment in the future. To do this, they design a rationale based on the future success that the two companies will drive together, instead of the current performance of your company. Remember that you are selling a vision of the future that happens to be backed up by your credibility. Founders need to deeply understand the acquirer’s business to articulate a defensible rationale.
Facebook knocked this out of the park with its acquisition of Instagram. It was clear that the Facebook team was falling behind on mobile user growth. The tech giant lacked the technology talent and the infrastructure to translate its web-based technology to the growing mobile market. Instagram was clearly ahead, and the rates of growth indicated that each passing day made the budding photo-sharing app more valuable.
The Instagram acquisition is a longer story that we will visit during Part 2, but suffice to say Mark Zuckerberg was initially considered a fool for paying close to $1 billion for the photo-sharing app. Nearly a decade later, Facebook makes over $20 billion in ad revenue per year from Instagram, nearly a fifth of all Facebook revenues.
While Instagram is the crown jewel of Facebook’s acquisition portfolio, not every megamerger means a successful future. One of the most visible examples of bad rationale happened in the largest acquisition in tech history — when Time Warner and AOL joined forces. While it made for a good headline, most of the operators working on the deal could not articulate why it made sense for the two companies to join forces.
The rationale is the most critical component of a transaction. Know that as the world changes, so will the rationale. It is critical to build the alignment around the shared objective; this will be the fundamental driver of the transaction.
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